Quarterly profits for Luxembourg-based banks before provisions and taxes reached €3.106bn in the second quarter of 2024, data from the Luxembourg Central Bank shows. This figure represents more than double the quarterly average of €1.324bn recorded between 2008 and 2021.

Similarly, the net interest margin--the difference between the interest earned by banks and the interest paid on deposits and other sources--has also experienced significant surge, the data shows. The net interest margin has remained above €2.5bn for the past five quarters, nearly doubling its historic average of approximately €1.259bn.

“ What this income figure covers ”

In a statement to Paperjam, a spokesperson for the Luxembourg Bankers’ Association (ABBL) confirmed the rise in profits. The spokesperson agreed that, for the past two years, Luxembourg banks’ current revenues have consistently exceeded recent averages, “mainly [driven] from the net interest margin”. However, the spokesperson emphasised, “there is a need to start by explaining what this income figure covers.”

ABBL clarified that a bank’s net interest margin “is a key metric that measures the difference between the interest income generated by banks on loans and investments and the interest they pay to depositors and other funding sources.” But, “the first thing to remember is that it is not the banks that set the key interest rates, but the European Central Bank (ECB).”

 “The ECB raised these rates rapidly and significantly in 2022 in order to combat inflation. For the ECB, the banks are an instrument in this fight, as they adjust their lending and borrowing rates in the light of the ECB's key rates.”

However, with inflation now the ECB’s 2% medium-term target, the central bank has to wind down its interest rate increases.

Mortgages and loans

The ABBL representative noted that the increase in ECB rates has caused mortgage rates to rise sharply, resulting in a significant decline in the creation of new loans. Furthermore, many customers delayed their investment projects or no longer met the regulatory requirements for granting loans. In addition, the lending margins applied by banks remained more or less the same. “So, low loan volumes--even though loan production has risen slightly since the start of the year--plus stable margins means that the income generated in this area does not explain the significant rise in global net interest margins,” argued the ABBL.

The same applies to interest income. “Luxembourg is one of the European countries where the difference between the ECB’s key rates and the rates applied by banks to remunerate customer accounts is the smallest.” Therefore, the increase in income on global net interest margins does not come from this item either, the ABBL stated.

According to the ABBL, banks can employ several strategies to positively impact net interest margins. These include investing in higher-yielding loans or securities, attracting more non-interest-bearing deposits such as checking accounts, lending out a higher proportion of deposits, and issuing longer-term loans. These are just a few examples of the approaches banks can take.

Liquidity and interest margins

However, the main factor influencing banks’ interest margins is their substantial liquidity, stemming from the deposits entrusted to them by customers. And, “due to prudential regulations, not all of this liquidity can be used to grant loans: it has to be placed with central banks or on the interbank market.” When interest rates were negative, this posed a cost to banks. Now, at current rates, these investments yield around 4%, allowing banks to earn interest levels in line with historical averages, claimed the ABBL.

Additionally, “this exceptional situation also comes after a decade of low interest rates, a sharp rise in compliance costs and major investment in digital transformation.” Consequently, banks’ revenues had primarily depended on the productivity and efficiency gains they achieved during this long period. The ABBL contended, “Today, and for the past two years, banks have been making money again from a traditional and historic business.”

“Should we rejoice?”

Regarding the implications of these profits, the spokesperson remarked, “First of all, a profitable bank is a stable bank, which should reassure its customers.” A profitable bank also has the reserves necessary to grant credit to customers, thereby supporting the economy. Furthermore, it can make essential investments in compliance, security and the fight against financial crime. A bank that is financially healthy will be better positioned to ensure that its employees retain their jobs and remain employable. For instance, this stability allows the Luxembourg banking sector to sign a collective agreement emphasising training.

Moreover, it’s important to note that banks pay taxes on their income, which contributes to the state’s revenue and helps finance projects of general interest. In 2023, for example, banks paid a substantial €1.6bn in direct taxes, reflecting an increase of 104.6% from the previous year, the ABBL noted.

“Is this situation here to stay?”

As for the sustainability of this situation, the ABBL stated: “We need to be cautious here as the supervisory authorities keep reminding us.” It should be emphasised that as interest rates rise, “the cost of refinancing banks on the interbank market will also increase.” This refinancing often takes the form of long-term contracts that will gradually reach maturity, creating a time lag in the impact of rate changes. Furthermore, banks will need to increase their provisions to cover risks associated with the economic, climatic and geopolitical landscape, which will weigh on their revenues. ABBL concluded, “All in all, we can therefore conclude, as the Financial Sector Supervisory Commission (CSSF) also did in one of its statements, that concerning banks’ revenues we are witnessing an exceptional situation.”